I've read through the "Asking Portfolio Questions" sticky-topic but I don't think that I need to make a full report to answer this question:

Since investing a substantial amount in VTI, VOE, and VXUS last November I've seen significant gains (as have we all.)

My 2013 federal AGI, *including* capital gains, is likely to be less than $10,000 this year. (Unemployed.) I'm single, age 38, no dependents.

Given my very low tax bracket, and the fact that I can trade Vanguard ETFs without commission, does it make sense for me to harvest and immediately re-invest my VTI, VOE, & VXUS gains, to protect myself against a drop in the market?

I know that ordinarily the answer is "of course not" due to tax liability -- but since my income is going to be so low for 2013, will I not escape the worst of short-term capital gains tax effects?

Last edited by mancuso on Fri Feb 01, 2013 3:07 pm, edited 2 times in total.

If you have a TIRA that you previously funded, you could look into converting all or some of it into a Roth IRA. You would lock in your low current tax rate. It does not count toward the contribution limit.

1) Are you sure you will be unemployed all year? I like the "wait until December" idea myself.

2) Can you sell and re-buy an ETF right away? Vanguard has restrictions on doing that with mutual funds.

3) "Given my very low tax bracket, and the fact that I can trade Vanguard ETFs without commission, does it make sense for me to harvest and immediately re-invest my VTI, VOE, & VXUS gains, to protect myself against a drop in the market? "I think it makes sense up to the top of the 15% bracket (where there will be no tax). But you will not protect yourself from a drop in the market. What you would be doing is raising the basis of your shares (reducing taxes at some later date).

3) I would also look into converting tIRA (if you have any) to Roth IRA in the 10% and maybe 15% brackets. But frankly, I'm not sure if that sits higher or lower in the "stack" (or at the same level) than capital gains.

Mancuso wrote: does it make sense for me to harvest and immediately re-invest my VTI, VOE, & VXUS gains, to protect myself against a drop in the market?

How does selling and immediately reinvesting help protect you from a drop in the market? Do you mean because of significant gains your asset allocation is now higher in stocks than target and you want to sell some to rebalance, or do you want to back out of equities because of a market drop? If your goal is to rebalance, you should do that in your tax deferred accounts if you have any equity there. If not, sell and buy non-equity to get back to target.

Paul

When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

1) Are you sure you will be unemployed all year? I like the "wait until December" idea myself.

2) Can you sell and re-buy an ETF right away? Vanguard has restrictions on doing that with mutual funds.

3) "Given my very low tax bracket, and the fact that I can trade Vanguard ETFs without commission, does it make sense for me to harvest and immediately re-invest my VTI, VOE, & VXUS gains, to protect myself against a drop in the market? "I think it makes sense up to the top of the 15% bracket (where there will be no tax). But you will not protect yourself from a drop in the market. What you would be doing is raising the basis of your shares (reducing taxes at some later date).

3) I would also look into converting tIRA (if you have any) to Roth IRA in the 10% and maybe 15% brackets. But frankly, I'm not sure if that sits higher or lower in the "stack" (or at the same level) than capital gains.

1 - I'm planning to remain unemployed this year for a variety of personal reasons.2 - To my understanding & knowledge, there are no applicable frequency restrictions on trading Vanguard ETF's. (I.e. there's no 60-day lock-out as there are with some VG mutual funds.)3- I don't have a tIRA.

As long as I'm sure I'm not going to pay capital gains on the sale-and-reinvest, I think it makes sense for me to raise my cost basis.

mancuso wrote:Given my very low tax bracket, and the fact that I can trade Vanguard ETFs without commission, does it make sense for me to harvest and immediately re-invest my VTI, VOE, & VXUS gains, to protect myself against a drop in the market?

I'm going to pile in with the one other response pointing out that selling and reinvesting has nothing to do with some theory of protecting yourself from a drop in the market. So the answer is, no; this is nonsense. The rest of the answers about tax management and so on are fine.

The one thing one might do after a market rise is rebalance if one is over allocated to stocks. It makes sense to do that especially when at low tax cost. One could call that protection against a drop in the market in the sense of taking risk back to the original target allocation and one could even say one had "locked in" gains although that isn't really the concept here.

retiredjg wrote:So you contributed to Roth IRA for 2013. That can be reversed. Find out about "recharacterization".

Wouldn't recharacterization mean turning the Roth IRA into a TIRA? He couldn't do that, because with no income he doesn't qualify for any kind of IRA.

Reversing his contributions would mean withdrawing the original contributions plus net income attributable. The NIA is what OP should research and calculate in order to get rid of these erroneous contributions.

Recharacterizations only apply to Roth Conversions, but there are rules for Excess Contributions to a Roth IRA. Per IRS Pub 590:

Withdrawal of excess contributions. For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed. This treatment only applies if any earnings on the contributions are also withdrawn. The earnings are considered earned and received in the year the excess contribution was made.

If you timely filed your 2011 tax return without withdrawing a contribution that you made in 2011, you can still have the contribution returned to you within 6 months of the due date of your 2011 tax return, excluding extensions. If you do, file an amended return with “Filed pursuant to section 301.9100-2” written at the top. Report any related earnings on the amended return and include an explanation of the withdrawal. Make any other necessary changes on the amended return.

The only way to correct the excess contribution without paying additional penalties seems to be to withdraw the excess contribution before the following April (that will be tax and penalty free as usual for Roths), and then withdraw any gains that contribution has earned (that is the NIA). Those gains would be subject to tax and to the early withdrawal penalty.

If you have a TIRA that you previously funded, you could look into converting all or some of it into a Roth IRA. You would lock in your low current tax rate. It does not count toward the contribution limit.

Of course if you do not have a TIRA then it is irrelevant.

In case it's still not clear, which it doesnt seem to be, you'll need to return your excess controbutions then do a Roth conversion assuming you have untaxed retirement accounts.

Thanks for the correction. I think you may be right that I used the wrong term. It probably is an "excess contribution". I read a thread lately about recharacterizing back to "never happened", but that might simply have been incorrect terminology as well.

However, as I understand it, a recharacterization does not only apply to a Roth conversion. You can recharacterize a Roth contribution to tIRA and vice versa.

retiredjg wrote:However, as I understand it, a recharacterization does not only apply to a Roth conversion. You can recharacterize a Roth contribution to tIRA and vice versa.

This is correct. From Pub 590 (emphasis mine):

You may be able to convert amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA. You may be able to roll over amounts from a qualified retirement plan to a Roth IRA. You may be able to recharacterize contributions made to one IRA as having been made directly to a different IRA. You can roll amounts over from a designated Roth account or from one Roth IRA to another Roth IRA.